MACRO - LS12 - Demand-Side Policies (Part 3)

Question 1

what policies do Keynesian economists use?

Answer 1

fiscal and monetary policy

Question 2

what policies do Classical economists use?

Answer 2

monetary policies, argue fiscal policies are ineffective

Question 3

strengths/weaknesses of demand-side policies

Answer 3

• speed of adjustment
• conflicting policies
• national debt
• rate of interest
• quantitative easing
• size of multiplier
• time lags
• fine-tuning

Question 4

speed of adjustment

Answer 4

• Keynesian economists argue an economy can be in short-term disequilibrium for years due to lack of demand, due to lack of spending (AD)
• Classical economists argue economies adjust quickly, if LT unemployment with no economic growth, its not due to recession, it’s due to supply-side problems, demand-side policies will have no effect

Question 5

conflicting policies

Answer 5

• Keynesian economists argue gov should use expansionary monetary & fiscal policy to grow economy
• since 2008, some right wing economists argue fiscal policy should be contractionary & monetary policy should be expansionary
• as costs of increasing national debt from expansionary fiscal policy is greater then any benefits to AD

Question 6

National debt

Answer 6

• expantionary fiscal policy can increase AD in recession, but also increases national debt
• some argue benefits to AD outweigh costs
• Keynesian economists argue that as long as gov can print money to finance deficit without increasing inflation or borrow money from financial markets, then national debt isn’t short term problem
• most economists agree National debt is problem in LT, esp. if financed from borrowing foreign money

Question 7

rate of interest

Answer 7

• central bank cut rates in recession to stimulate AD
• Although in 2008 crisis, rates were low but didn’t impact AD
• so interest rates have limited effectiveness

Question 8

Quantitative easing

Answer 8

• some economists argue it boosts AD - as borrow to spend on real goods/services
• others argue pushes up asset prices and households and firms borrow to buy second hand homes instead of new ones, pushing up prices but not AD

Question 9

Time Lags

Answer 9

• generally demand-side policies have time lags
• by the time project starts, economic situation likely to have changed
• demand-side policies need to be effective on changing AD within short term period

Question 10

fine-tuning

Answer 10

• most economists today agree it’s impossible
• too many small/large, random shocks to economic system
• also too little precision about the tools of demand-side policies for this work

Question 11

Great Depression

Answer 11

• took place in 1930’s
• started in US after major fall in stock prices
• worldwide GDP fell by an estimated 15%

Question 12

UK policy response to great depression (fiscal)

Answer 12

• gov revenue fell, benefits rose, expected increasing budget deficit
• classical policy was mainstream in 1920’s
• gov followed deflationary fiscal policy, cut gov spending, e.g benefits, public sector pay
• meant recession was worse

Question 13

UK policy response to great depression (monetary)

Answer 13

• contractionary due to Gold Standard
• system where currency could be swapped for fixed amount of gold in central bank, currency was fixed depending on amnt of gold held
• couldn’t use expansionary policy e.g. increasing money supply, decreasing interest rates
• exchange rates was fixed, pound overvalued
• economy recovered when UK left gold standard in 1931 - interest rates lowered, pound devalued - consumption and investment increased

Question 14

US policy response to great depression

Answer 14

• Economic policies during the Great Depression were laissez-faire - leaving the economy to market forces, with minimal interference by the government
• Taxes were generally kept low to encourage businesses to invest more and consumers to spend more. However, as government revenue fell during the Great Depression, taxes were increased (as in the UK) to avoid a budget deficit.
• In 1933, Franklin D. Roosevelt became the new President of the USA & laissez-faire policies, and introduced the ‘New Deal’ - this included expansionary policies which increased government spending, for example government-funded jobs for the unemployed and large infrastructure projects.
• These projects reduced unemployment and poverty. However, unemployment began to rise again in the late 1930s. It eventually fell when defence spending during WW2 contributed to economic recovery (as it had in the UK).

Question 15

UK policy response to financial crisis (fiscal policy)

Answer 15

• a tax cut for basic rate tax payers, a temporary 2.5 percentage point cut in the VAT rate, £3 billion worth of investment spending brought forward from 2010 and a variety of other measures such as a £20 billion Small Enterprise Loan Guarantee Scheme
• Further measures were unveiled in the 2009 Budget, including training help for the young unemployed and a ‘car scrappage scheme
• However, from 2010 focus moved to measures to reduce the budget deficit.

Question 16

US policy response to financial crisis (fiscal policy)

Answer 16

• In 2008, the US government instituted the Economic Stimulus Act of 2008, a $152 billion fiscal stimulus package
• This was followed by the American Recovery and Reinvestment Act of 2009, a $787 billion bill which involved government spending over a period of several years

Question 17

UK policy response to the financial crisis (monetary policy)

Answer 17

• MPC cut the Bank Rate from 5.75% to 5.5% in December 2007
• Over the course of 2008 it was cut a further five times, to take it to 2.0% by the end of the year
• Three further cuts in the first three months of 2009 took it to a historic low of 0.5% in March 2009.
• Between March and November 2009, the MPC authorised the purchase of £200 billion worth of assets, mostly UK government debt or ‘gilts’
• The MPC voted to begin further purchases of £75 billion in October 2011 and, subsequently, at its meeting in February 2012 the Committee decided to buy an additional £50 billion
• In July the MPC announced the purchase of a further £50 billion to bring total assets purchases to £375 billion

Question 18

US policy response to the financial crisis (monetary policy)

Answer 18

• Federal Reserve cut the interest rate from 5.25% to 4.25% over the final three months of 2007, and then cut it a further seven times over the course of 2008, to go to a rate of 0-0.25%
• In addition, the US used three rounds of quantitative easing (QE) in order to boost the money supply - QE1 in 2008-2009, QE2 in 2010 and QE3 in 2012.
• These led to the Federal Reserve increasing the value of the assets it held from less than $1 trillion in 2007 to more than $4 trillion in January 2014.
• Despite the size of this increase, economists are still debating how effective QE has been.